China's yuan slides to near one-year low as economic risks mount

China's yuan fell beyond 6.20 to the dollar on Wednesday for the first time since April last year amid market speculation the central bank will keep the currency weak as economic growth slows.

The yuan has tumbled 0.8 percent so far this week after the People's Bank of China (PBOC) on Saturday doubled the daily trading band allowed for the currency to 2 percent from the mid-point that it sets each day.

Spot yuan briefly fell as low as 6.2040 in early afternoon trade before ending at 6.1965. That marked a 0.07 percent loss on the day from Tuesday's close, and a fall of 1 percent from the mid-point.

"We see risks of further near-term yuan weakness, but do not expect this to extend beyond the second quarter. It is not in the PBOC's interests to have a sustained depreciation in the currency, as this will increase financial stability risks," economists at ANZ said in a research note.

Other analysts agreed that allowing the yuan to weaken too far, too fast would only increase the stresses on Chinese companies and the broader economy.

ANZ expects the currency to return to a modest appreciation trend in the second half, but still end the year weaker for the first time since Beijing unshackled it from its fixed exchange rate to the dollar in 2005.

The currency has risen more than 30 percent since then, attracting a growing number of global investors, big and small, many of whom have come to see it as a one-way appreciation bet.

ANZ like many other market watchers has now dialed back expectations for the yuan, revising its year-end yuan forecast to 6.08 from 5.98.

"The yuan may not appreciate this year given China's weak economy," agreed one trader in Shanghai. "The return of yuan strength will not only rely on when the economy bottoms out, but when fresh long yuan funds come in."

While the recent slide in the yuan is widely seen as a move engineered by the central bank to punish speculators, it has coincided with heightened anxiety among global investors that long-standing risks in China may be coming to a head.

The economy clearly lost steam in the first two months of the year and rising debt worries following the country's first domestic bond default are adding to pressure on its currency and stock markets. A flurry of local media reports of troubled steel and property companies have compounded market jitters.

Some traders suggested the yuan's decline may reflect policymakers' desire to offer some help to the sluggish economy, by effectively easing monetary conditions, while others said that may only be a welcome side-effect of the PBOC's move to deepen market reforms.

Speculation that Beijing may soon announce stimulus measures for the economy has grown since data last week showed growth in investment, retail sales and factory output all falling to multi-year lows.

"The currency band widening at this moment has two advantages. One is to signal that the reform agenda will not be easily given up despite weak economic condition. Second, while band widening itself has little impact on the economy, the possible consequence could be used to stabilize growth," said Zhu Haibin, an analyst at JP Morgan.

However, not all traders subscribe to that view. Others said the yuan's decline reflected genuine trade as investors reduced long positions in the currency as the PBOC looks to implement deeper reforms.

They pointed to the fact that just two days into the 2 percent band regime, the market had already moved the currency by the equivalent of the previous band's 1 percent limit.

When the band was last widened in 2012 - to 1 percent from 0.5 percent - it took the market two weeks to build up the courage to test even the previous band's width given how closely the central bank controls the market.

Indeed, in recent weeks sentiment on the Chinese yuan had already turned bearish for the first time since mid-2012 as the PBOC rounded on speculators and looked to curb hot money inflows, a Reuters poll showed last week.

A weaker currency could also work against exporters if it also grows more volatile, raising their hedging costs.

OFFSHORE YUAN ALSO VULNERABLE

The yuan's decline reverberated offshore, where the currency's non-deliverable forwards (NDFs) indicated further weakness to come.

One-year NDFs priced the yuan 1.5 percent below the mid-point fixing, compared with half a percent in December.

Deliverable yuan in Hong Kong fell to its lowest level since April 2013, with traders predicting further weakness because structured product positions could come under pressure.

Offshore yuan fell to 6.1995 per dollar in afternoon trade, extending a streak that has seen it weaken by 2.6 percent in nearly a month, wiping out its 2013 gains. It later regained some strength and traded at 6.1855.

"Investors are deleveraging the yuan appreciation expectations in the short-term following the band widening," said a dealer in Hong Kong.

The fall in the offshore yuan spot rate to nearly 6.20 per dollar, the lowest level in more than 11 months, is pressuring lots of structured yuan products which were originally sold around that level, pointing to the risk of a blowout on the short-end volatility curve.

More than $300 billion of these structured products have been sold since 2013 and the yuan's drop has raised the chances of some of these products defaulting, adding another destabilizing factor in the market.

Analysts say they expect further market reforms following the widening of yuan band. The next meaningful reform would be for Beijing to shift to a new market-based regime and away from setting the daily yuan fixing.

As an intermediate step, China could peg the yuan to a basket of currencies weighted by the importance of its trading partners. Lu Ting, an analyst at Bank of America Merrill Lynch said that more specifically, Singapore's so-called BBC regime, or basket, band and crawl, seems to be favored.

In some countries where hungry investors have jumped into yuan-related investment products, regulators are also expressing concern about risks as the currency becomes increasingly adopted worldwide.

South Korean regulators are inspecting units of four foreign banks, sources told Reuters on Wednesday, as authorities worry about systemic risks from the rapid growth in yuan-denominated deposits. In Taiwan, where the yuan accounted for a fifth of the island's total foreign currency deposits in January, regulators recently warned investors to expect more volatility in yuan.

The yuan surpassed the Swiss franc to become the seventh most-used world payments currency in January, global transaction services organization SWIFT said.

The "redback" is now only ranked behind the U.S. dollar, euro, sterling, yen, Canadian dollar and Australian dollar in terms of global payments, according to SWIFT.

(Editing by Neil Fullick & Kim Coghill)